Profit-taking and Reduced Overweight in Peripherals

Global Context

Activity-cycle momentum continues to build in the Eurozone and in Japan, with the expansion stage remaining well-anchored in both regions. The Eurozone in particular has seen the unemployment component finally contribute positively to the overall indicator. In the US, while weaker ISM figures have dragged the activity-cycle indicator lower, the overall outlook now appears to be rather mixed, thanks to strong manufacturing PMI prints and low unemployment figures. The consequences of the disaster caused by hurricane Harvey as well as the progress around the much-awaited tax reforms and fiscal stimulus are important factors to be monitored in order to determine the state of the US economy, which remains unclear as we appear to be nearing the end of the expansion phase of the activity cycle. The other developed countries are a mixed bunch, as Australia and Canada (which continues its acceleration) are in the expansion stage, while the UK and Sweden are experiencing a downturn. On the debt cycle, the slowdown in US credit creation continues (lower M&A activity and weaker loan demand), while Europe and Japan now appear to be taking the lead.

After marking a peak in June, the inflation indicators in the G4 countries are trending lower. In Europe, though sub-indicators remain relatively strong, some of the recent weakness can be attributed to the stronger euro, as well as to lower wage inflation. Expectations and consumer prices are also driving downwards the US inflation indicator, as it pursues its sharp retracement. Overall, inflation expectations have declined over the past month and our indicator seems to be suggesting that most G10 countries are increasingly likely to experience softer inflationary pressures.

On the monetary-policy front, the much-awaited Jackson Hole symposium (at which hints on upcoming decisions were expected) resulted in a collective silence of central bankers on future monetary policies. Overall, the trend still indicates less monetary support, as we await an announcement on ECB QE tapering in October and a reduction in the Fed balance sheet before the end of the year. We note, however, that inflation continues to stubbornly trend below targets. In this context, central banks would be under less pressure to engage in monetary normalisation immediately. Close attention to political risks will be necessary as a result of heightened tensions between the US and North Korea over missile-testing, the uncertainty that continues to hang over the Trump administration’s ability to pass a fiscal reform package and the tough rhetoric being heard at every turn of the Brexit negotiations.

GLOBAL RATES STRATEGY

Spread trade long US vs. short Eurozone

With uncertainty hanging over the current inflation levels and questions over the ability of president Trump to finally deliver on the fiscal stimulus policies, we are maintaining our current long position on US rates. Treasuries are also likely to rise in the wake of the geopolitical risk present as a result of tensions between the US and North Korea. In Europe, on the other hand, the continuous rise in the activity cycle and the probable tapering of the ECB QE has incited us to hold a short position on the EUR curve. Valuations continue to be at extreme levels, especially in German rates, thereby comforting us in our strategy.

Profit-taking and Reduced Overweight in Peripherals

The non-core European bond markets continue to be supported by the ECB, and flow dynamics are also positive. Furthermore, investor-positioning remains close to its record lows. We are hence overweight Spain, where valuations are still relatively attractive, and have taken profit on our long position in Portugal, which had delivered a strong performance. However, in the wake of political tensions in Italy (on the back of Berlusconi’s anti-European rhetoric and its potential impact on the general elections early next year), we are maintaining a neutral stance on the country’s sovereign debt. .